Introduction

Estate planning is a lot like putting together a puzzle. The client provides you with their box lid showing what they want the ultimate result of their plan to look like. Then, estate planners are tasked to identify and gather the various pieces and put it all together. An important piece of any estate planning puzzle is tax planning. While the federal government rarely misses an opportunity to take a share for itself when monies are exchanged, two powerful tools are helpful when incorporating that tax piece into a client’s puzzle: (1) the federal estate tax exemption; and the (2) annual and lifetime gift tax exclusions.

Thanks to the Economic Recovery Tax Act of 1981, married U.S. citizens can essentially transfer an unlimited amount of money between one another, while living or upon death, without triggering a taxable event. However, the script flips when a client gifts outside of a marriage, such as to children, siblings, or other members of their family… enter the federal estate tax exemption and the annual gift tax exclusion.  The federal estate tax exemption allows a U.S. client to gift at death up to a certain amount, outside of a marriage, without incurring a tax penalty and the annual gift tax exclusion allows a U.S. client to gift during their lifetime up to a certain amount each year, outside of a marriage, without incurring a tax penalty. Careful planning on how best to incorporate these pieces into any estate puzzle can result in significant tax savings for clients and their families.

Federal Estate Tax Exemption Increase for 2024

The current (2023) federal estate tax exemption amount is $12,920,000.00, meaning a U.S. client, who dies in 2023 can gift at death from their taxable estate up to $12,920,000.00. This exemption amount is per U.S. client, meaning the current federal exemption amount for a U.S. couple is $25,840,000.00.  On November 9, 2023, the IRS released the new (2024) federal estate tax exemption amount, which will be $13,610,000.00 per U.S. client ($27,220,000.00 for a U.S. couple).

The Federal Estate Tax has been around in some form since the Revenue Act of 1916. However, Congress has since passed legislation exempting estates under certain values from the Federal Estate Tax. The exemption values have changed over time. In 2010, through the 2010 Tax Relief Act, the Federal Estate Tax Exemption was set at $5,000,000 (indexed for inflation thereafter). In 2017, through the 2017 Tax Cuts and Jobs Act, the Federal Estate Tax Exemption, which was then $5,490,000, doubled to $11,180,000 (indexed for inflation thereafter).

The November 9, 2023, publication by the IRS continues the inflation adjustments required under the 2017 Tax Cuts and Jobs Act.

Federal Annual and Lifetime Gift Tax Exclusion Increase for 2024

Regarding annual gifts, the current (2023) federal annual gift tax exclusion is $17,000.00 per U.S. client and $34,000.00 per U.S. couple.  The new (2024) federal annual gift tax exclusion amount will be $18,000.00 per U.S. client ($36,000.00 for a U.S. couple). The Revenue Act of 1924 first introduced the gift tax in the United States, which was repealed two year later, but permanently reinstated by the Revenue Act of 1932. The Taxpayer Relief Act of 1997 authorized the annual gift tax exclusion to be indexed for inflation in increments of $1,000.00. Like the federal estate tax exemption amount, the November 9, 2023 publication by the IRS also continues the required inflation adjustments. Any gift made by a client in excess of such exclusion amount needs to be reported on a Form 709 gift tax return and is subject to incurring a tax on the amount in excess of the exclusion at a rate between 18% and 40% depending on the income bracket of the donor.

Regarding cumulative lifetime gifts, the lifetime gift tax exclusion was born from the Tax Reform Act of 1976 when Congress:

“Merged the federal estate tax exclusion and the lifetime gift tax exclusion into a ‘single, unified estate and gift tax credit, which may be used to offset gift tax liability during the donor’s lifetime, but which if unused at death, is available to offset the deceased donor’s estate tax liability.”

So, if a U.S. client gifts more than the annual gift tax exclusion amount, then the U.S. client may elect to use their unified credit, which reduces the amount they can exempt from estate taxes in an amount equal to the value of the gift made during their lifetime. This essentially allows a U.S. client to gift an amount equal to the federal estate tax exemption during their lifetime. So, the current (2023) lifetime gift tax exclusion is $12,900,000.00 and the new lifetime gift tax exclusion (2024) will be $13,610,000.00 per U.S. client.

Further, in order for a gift to be excluded under the annual and lifetime gift tax exclusions, the gift needs to be a present interest as opposed to a future interest meaning the beneficiary has immediate use and benefit of the gift.

Impact of the Changes

The new (2024) exemption and exclusion amounts are record-setting highs providing perhaps the most favorable tax environment to date for tax planning. The continued increase to the federal estate tax exemption and gift exclusion amounts provide estate planners and clients with increased gifting options. Clients looking to make lifetime gifts should consider fully utilizing their annual gift tax exclusion and clients, who are projected to be above the federal estate tax exemption, should consider utilizing their lifetime gift tax exclusion before it is too late.

Regarding annual gifts, a U.S. client can gift in 2024 up to $18,000 per donee. So, if a U.S. couple has four children, they can gift up to $144,000.00 tax free. Annual gifting can be a highly effective strategy to reduce the taxable estate of a client who is projected to have an estate greater than the federal estate tax exemption.

Regarding lifetime gifts, while the federal estate tax exemption is at a record high, the 2017 Tax Cuts and Jobs Act included a sunset provision, which will revert the federal estate tax exemption back to where it was prior to its passage. The anticipated post 2025 federal estate tax exemption, adjusted for inflation, is expected to be somewhere around $7,000,000.00 come January 1, 2026. Consequently, come 2026, each U.S. client is set to lose at least $6,000,000.00 of exemption. So, for high-net worth U.S. citizens, now is the time to consider making substantial lifetime gifts utilizing their unified credit toward the currently record high federal estate tax exemption. Failing to do so, may result in substantial federal estate taxes, which could be as high as 40%. Further, making large gifts now will not harm estates after 2025, creating a true “use it or lose it” scenario.

For example, if a client has a net worth of $15,000,00.00 and dies in 2026, their estate may only be protected by a federal estate tax exemption of $7,000,000, resulting in $8,000,000 being taxed at 40%, which would result in a tax liability exceeding $3,000,000.00. However, if the same client gifts $5,000,000 now utilizing their lifetime annual exclusion, their taxable estate would be $10,000,000.00 in 2026, which would result in only $3,000,000.00 being taxed at 40% cutting the tax liability by more than half. Ideally, if the U.S. citizen in this example is in a position to gift $8,000,000 using their unified credit, then they would have reduced their federal estate tax liability to zero, maximizing the gifts to their chosen and intended beneficiaries.

Conclusion

For estate planners with clients whose estates will exceed the anticipated 2026 Federal Estate Tax Exemption, time is ticking in a use it or lose it situation with the risk of clients paying up to forty cents on every dollar over the exemption to the government instead of their family or chosen beneficiaries. Unless Congress removes or delays the sunset provision of the 2017 Tax Cuts and Jobs Act, careful tax planning must be of utmost priority. Otherwise, estate planners may lose a vital piece of completing the puzzle for their clients.

Given the recent IRS adjustments, proactive estate planning becomes essential for securing your financial legacy.